Internal Revenue Service
Revenue Ruling
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smRev. Rul. 75-93
1975-1 C.B. 101
Sec. 305
IRS Headnote
Recapitalization; proportionate interest increased. A recapitalization in which the shares of one of two classes of common stock (with equal voting rights and previously sharing in dividends and liquidating distributions according to their par values at a 10-to-1 ratio) were exchanged for stocks of the higher par value at an exchange rate of 7-to-1, thereby increasing the exchanging shareholders' proportionate interests in the assets or earnings and profits of the corporation, was an isolated transaction not part of a plan to periodically increase their interest and is not deemed, under section 305(c) of the Code, to result in a distribution to which sections 305(b)(2) and 301 apply.
Full Text
Rev. Rul. 75-93
Advice has been requested whether, under the circumstances described below, the provisions of section 305(b)(2) of the Internal Revenue Code of 1954 apply to a recapitalization under section 368(a)(1)(E).
X had outstanding 700x shares of $2.00 par value class A common stock, 2,100x shares of $0.20 par value class B common stock, and 62x shares of no-par-value convertible preferred stock. All of the class B common stock was held by officers and directors of X who owned no class A common stock. The class A common stock was widely held and traded in the over-the-counter market. Regular cash dividends are paid on the preferred stock.
The class A common stock and class B common stock, both subordinated to the preferred stock, shared in dividends and liquidating distributions in relation to their par values, that is 10 to 1. The class A common stock and class B common stock each carried one vote per share. Therefore, as a class, the class A common stock represented 25 percent of the voting power of X, and the class B common stock represented 75 percent. The preferred stock is convertible into class A common stock of X at a fixed conversion price and is fully protected against dilution in the event of a stock dividend or stock split.
X recapitalized for valid business reasons in a transaction satisfying the definition of a reorganization described in section 368(a)(1)(E) of the Code and exchanged shares of unissued class A common stock for all of the outstanding shares of class B common stock. Since each share of class B common stock shared in dividends and liquidating distributions to the extent of one-tenth of the class A common stock, ten shares of class B common stock should have been exchanged for one share of class A common stock, for an aggregate of 210x shares of class A common stock. Since it had more voting power as a class, however, the class B common stock was more valuable than the class A common stock. Therefore, seven shares of class B common stock were exchanged for one share of class A common stock, for an aggregate of 300x shares of class A common stock.
As a result of the recapitalization, the former class B shareholders increased their proportionate interests in the assets and earnings and profits of X by receiving 90x shares of class A common stock in the exchange attributable to the surrender of their concerted voting power in X. The recapitalization was an isolated transaction and was not part of a plan to periodically increase a shareholder's proportionate interest in the assets or earnings and profits of X.
Section 305(b)(2) of the Code provides that a distribution (or a series of distributions of which such distribution is one) by a corporation of its stock shall be treated as a distribution of property to which section 301 applies if it has the result of (1) the receipt of money or other property by some shareholders, and (2) an increase in the proportionate interests of other shareholders in the assets or earnings and profits of the corporation.
Section 305(c) of the Code provides, in part, that the Secretary shall prescribe the circumstances under which any transaction (including a recapitalization), that has the effect of a distribution described in section 305(b), will be treated as a distribution under section 301 with respect to any shareholder whose proportionate interest in the earnings and profits or assets of the corporation is increased by the transaction.
Section 1.305-3(b)(2) of the Income Tax Regulations provides that in order for a distribution of stock to be considered as one of a series of distributions it is not necessary that such distribution be pursuant to a plan to distribute cash or property to some shareholders and to increase the proportionate interests of other shareholders. It is sufficient if there is an actual or deemed distribution of stock and, as a result of such distribution, some shareholders receive cash or property and other shareholders increase their proportionate interests. This is so whether the stock distributions and the cash distributions are steps in an overall plan or are independent and unrelated. In addition, section 1.305-3(b)(3) states that there is no requirement that both elements of section 305(b)(2) of the Code (receipt of cash or property by some shareholders and an increase in proportionate interests of other shareholders) occur in the form of a distribution or series of distributions as long as the result of a distribution of stock is that some shareholders' proportionate interests increase and other shareholders in fact receive cash or property.
Section 1.305-7(a) of the regulations provides, in part, that a transaction, including a recapitalization, described in section 305(c) of the Code will be treated as a distribution to which sections 305(b) and 301 apply if (1) the proportionate interest of any shareholder in the earnings and profits or assets of the corporation deemed to have made such distribution is increased by such transaction, and (2) such distribution has the result described in paragraph (2), (3), (4) or (5) of section 305(b). Section 1.305-7(c)(1) provides that a recapitalization, whether or not an isolated transaction, will be deemed to result in a distribution to which section 305(c) applies if it is pursuant to a plan to periodically increase a shareholder's proportionate interest in the assets or earnings and profits of the corporation.
Section 305(b)(2) of the Code is applicable to a transaction only if there is an actual distribution or a deemed distribution within the meaning of section 305(c). There was no actual distribution in this case. Since the recapitalization was not part of a plan to periodically increase a shareholder's proportionate interest, there was no deemed distribution within the meaning of section 305(c). Thus, the transaction was not a distribution to which section 305(b)(2) applies. This is so notwithstanding the fact that the recapitalization had the effect of a transaction described in that section since the former class B shareholders increased their proportionate interests in the assets and earnings and profits of X by receiving additional shares of class A common stock in exchange for the surrender of their concerted voting power in X while other shareholders (the preferred shareholders) received money in the form of regular cash dividends paid on the preferred stock.
This is consistent with the conclusions reached in Examples (10), (11), and (13) in section 1.305-3(e) of the regulations where isolated redemptions do not cause section 305(b)(2) to apply even though there are increased proportionate interests in the assets and earnings and profits of the corporations by some shareholders and receipts of property by other shareholders.
Accordingly, the recapitalization in the instant case is not deemed, under section 305(c) of the Code, to result in a distribution to which sections 305(b)(2) and 301 apply.